SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-QSB (Mark One) [ X ] Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 2001 [ ] Transition Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to ---------------------- ----- Commission File Number: 33-84336-LA JetFleet III (Name of small business issuer in its charter) California 94-3208983 (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 1440 Chapin Avenue, Suite 310 Burlingame, California 94010 (Address of principal executive offices) (Zip Code) Issuer's telephone number, including area code: (650) 340-1880 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: None Check whether the Issuer: (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ---- ---- On November 14, 2001 the aggregate market value of the voting and non voting Common equity held by non-affiliates (computed by reference to the price at which the common equity was sold) was $0. As of November 14, 2001 the Issuer has 815,200 Shares of Common Stock and 195,465 Shares of Series A Preferred Stock outstanding. Transitional Small Business Disclosure Format (check one): Yes No X__ ------- ------ Part I. Financial Information Item 1. Financial Statements JETFLEET III Balance Sheet September 30, 2001 ASSETS Current assets: Cash $ 4,523,130 Deposits 1,378,780 Accounts receivable 35,270 Rent receivable 28,000 ------------- Total current assets 5,965,180 Aircraft and aircraft engines under operating leases, net of accumulated depreciation of $2,125,890 8,355,030 Debt issue costs, net of accumulated amortization of $1,185,160 476,290 Deferred taxes 135,460 Prepaid expenses 3,710 ------------- Total assets $ 14,935,670 ============= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 32,990 Payable to affiliate 3,480 Interest payable 152,120 Prepaid rents 38,720 Security deposits 166,000 Maintenance deposits 1,242,470 Taxes payable 960 ------------- Total current liabilities 1,636,740 Medium-term secured bonds 11,076,350 ------------- Total liabilities 12,713,090 ------------- Preferred stock, no par value, 300,000 shares authorized, 195,465 issued and outstanding 1,661,450 Common stock, no par value, 1,000,000 shares authorized, 815,200 issued and outstanding 815,200 Accumulated deficit (254,070) ------------- Total shareholders' equity 2,222,580 ------------- Total liabilities and shareholders' equity $ 14,935,670 ============= See accompanying notes. JETFLEET III Statements of Operations For the Nine Months Ended For the Three Months Ended September 30, September 30, 2001 2000 2001 2000 ---- ---- ---- ---- Revenues: Rent income $ 1,489,690 $ 1,703,390 $ 452,070 $ 567,250 Gain on sale of aircraft 494,450 - 147,750 - Interest income 153,940 93,760 49,000 38,490 ------------- ------------- ------------- ------------- 2,138,080 1,797,150 648,820 605,740 ------------- ------------- ------------- ------------- Expenses: Depreciation 402,080 479,140 117,900 162,710 Provision for impairment in value of aircraft - 150,700 - 150,700 Amortization 171,470 171,470 57,160 57,160 Interest 684,520 684,520 228,170 228,170 Maintenance 288,530 140,730 43,660 112,140 Professional fees and general and administrative 29,090 77,660 9,490 47,500 Management fees 146,600 146,600 48,860 48,860 ------------- ------------- ------------- ------------- 1,722,290 1,850,820 505,240 807,240 ------------- ------------- ------------- ------------- Income/(loss) before taxes 415,790 (53,670) 143,580 (201,500) Tax provision/(benefit) 149,800 (20,650) 51,770 (70,220) ------------- ------------- ------------- ------------- Net income/(loss) $ 265,990 $ (33,020) $ 91,810 $ (131,280) ============= ============= ============= ============= Weighted average common shares outstanding 815,200 815,200 815,200 815,200 ============= ============= ============= ============= Basic earnings/(loss) per common share $ 0.33 $ (0.04) $ 0.11 $ (0.16) ============= ============= ============= ============= See accompanying notes. JETFLEET III Statements of Cash Flows For the Nine Months Ended September 30, 2001 2000 ---- ---- Net cash provided by operating activities $ 348,230 $ 978,200 -------------- ------------- Investing activities: Purchase of interests in aircraft - (456,750) Proceeds from sale of aircraft 1,386,810 - -------------- ------------- Net cash provided by investing activities 1,386,810 (456,750) -------------- ------------- Net increase in cash 1,735,040 521,450 Cash, beginning of period 2,788,090 888,240 -------------- ------------- Cash, end of period $ 4,523,130 $ 1,409,690 ============== ============= Supplemental disclosures of cash flow information: Cash paid during the period for: 2001 2000 ---- ---- Interest $ 684,520 $ 684,520 Income taxes 500 21,400 See accompanying notes. JETFLEET III Notes to Financial Statements 1. Summary of Significant Accounting Policies Basis of Presentation JetFleet III (the "Company") was incorporated in the state of California in August 1994 ("Inception"). The Company was formed solely for the purpose of acquiring Income Producing Assets. The Company offered up to $20,000,000 in $1,000 Series A Units (the "Offering") consisting of $850 of bonds maturing on November 1, 2003 (the "Bonds") and $150 of preferred stock (the "Preferred Stock") pursuant to a prospectus dated September 27, 1995 (the "Prospectus"). All of the Company's outstanding common stock is owned by JetFleet Holding Corp. ("JHC"), a California corporation formed in January 1994. In May 1998, JetFleet Management Corp., the sole shareholder of the Company was renamed JetFleet Holding Corp. The rights and obligations under the management agreement between the Company and JHC were assigned by JHC to its newly-created wholly-owned subsidiary named "JetFleet Management Corp." ("JMC"). JMC also manages AeroCentury Corp., a Delaware corporation, and AeroCentury IV, Inc., a California corporation, which are affiliates of JHC and which have objectives similar to the Company's. Neal D. Crispin, the President of the Company, holds the same position with JHC and JMC and owns a significant amount of the common stock of JHC. Cash and Cash Equivalents/Deposits The Company considers highly liquid investments readily convertible into known amounts of cash, with original maturities of 90 days or less, as cash equivalents. Deposits represent cash balances held related to maintenance reserves and security deposits and generally are subject to withdrawal restrictions. As of September 30, 2001, the Company maintained $5,873,040 of its cash balances in two money market funds held by regional brokerage firms, which are not federally insured. Aircraft and Aircraft Engines Under Operating Leases The Company's interests in aircraft are recorded at cost, which include acquisition costs (see Note 2). Depreciation is computed using the straight-line method over each aircraft's estimated economic life to its estimated residual value. Impairment of Long-lived Assets In accordance with SFAS No. 121, "Accounting for the Impairment of Long-lived Assets and Long-lived Assets to Be Disposed Of," assets are reviewed for impairment whenever events or changes in circumstances indicate that the book value of the asset may not be recoverable. Periodically, the Company reviews its long-lived assets for impairment based on estimated future nondiscounted cash flows attributable to the assets. In the event such cash flows are not expected to be sufficient to recover the recorded value of the assets, the assets are written down to their estimated realizable value. Organization and Offering Costs Pursuant to the terms of the Prospectus, the Company paid an Organization and Offering Expense Reimbursement to JHC in cash in an amount up to 2.0% of Aggregate Gross Offering Proceeds for reimbursement of certain costs incurred in connection with the organization of the Company and the Offering (the "Reimbursement"). JETFLEET III Notes to Financial Statements 1. Summary of Significant Accounting Policies (continued) Organization and Offering Costs (continued) JHC contributed $450,000 of the total it paid for organization and offering expenses as a common stock investment in the Company (the "Initial Contribution"). The Company issued 450,000 shares of common stock to JHC in return for the Initial Contribution. To the extent that JHC incurred expenses in excess of the 2.0% cash limit, such excess expenses were repaid to JHC in the form of Common Stock issued by the Company at a price of $1.00 per share (the "Excess Stock"). The amount of Excess Stock that the Company issued was limited according to the amount of Aggregate Gross Offering Proceeds raised by the Company. The Company capitalized the portions of both the Reimbursement paid and the Initial Contribution related to the Bonds (85%) and amortizes such costs over the life of the Bonds (approximately eight years). The remainder of any of the Initial Contribution and Reimbursement is deducted from shareholders' equity. Assets Subject to Lien The Company's obligations under the Bonds are secured by a security interest in all of the Company's right, title and interest in the Income Producing Assets acquired by the Company. Income Taxes The Company follows the liability method of accounting for income taxes as required by the provisions of Statement of Financial Accounting Standards No. 109 - Accounting for Income Taxes. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from those estimates. Recent Accounting Pronouncements SFAS No. 137, which amended the effective date of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, was issued in June 1999. The Company adopted SFAS No. 133 on January 1, 2001. This statement establishes accounting and reporting standards requiring that all derivative instruments are recorded on the balance sheet as either an asset or a liability, measured at fair value. The statement requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met and such hedge accounting treatment is elected. Because the Company does not hold any derivatives as defined in SFAS No. 133, its adoption did not have a material impact on its results of operations or financial position. In December 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements ("SAB 101"). SAB 101, as amended, summarizes certain of the SEC's views in applying generally accepted accounting principles to revenue recognition in financial statements. SAB 101 was adopted by the Company in 2000. The adoption of the provisions of SAB 101 did not have a material effect on the Company's consolidated operating results, statement of financial position or cash flow. JETFLEET III Notes to Financial Statements 2. Aircraft and Aircraft Engines Under Operating Leases Aircraft and Aircraft Engines The Company owns a deHavilland DHC-8-100, serial number 13 ("S/N 13"), a Pratt & Whitney JT8D-9A aircraft engine, serial number 674267 ("S/N 674267"), three deHavilland DHC-6-300 aircraft ("S/Ns 640, 751 and 696") and a Saab 340A, serial number 24 ("S/N 24"). During January 2001, the Company sold its 50% interest in a Shorts SD 3-60, serial number S/N 3676 ("S/N 3676"). As discussed below, it also received, during June and July 2001, insurance and sales proceeds for its other Shorts SD 3-60, serial number S/N 3656 ("S/N 3656"). The Company did not purchase any aircraft during the first nine months of 2001. S/N 13 was re-leased in June 2000 to the same sub-lessee, an Australian carrier, for a one-year term. In May 2001, the lease was extended through August 14, 2001 and, at that time, was extended through October 31, 2001. It has since been extended through December 31, 2001 at reduced rent. The Company is currently discussing the terms of the lessee's continued use of the aircraft. S/N 674267 is used on a McDonnell Douglas DC-9 and is subject to a 60-month sublease, expiring in November 2001, between the seller and a Mexican based regional carrier. The Company is currently discussing remarketing terms with the lessee. S/Ns 640 and 751 are subject to similar 36-month leases, originally expiring in July 2001, with a U.S. regional carrier. Both leases were extended from their expiration dates to their pre-return inspection completion. S/N 751 was returned during August and, as discussed in Note 6, was re-leased during October. The Company is currently seeking re-lease opportunities for S/N 640, which the Company expects to be ready for return by year end. During June 2000, the Company and the lessee for S/N 696, which had been leased to the same carrier as S/Ns 640 and 751, agreed to an early termination of the lease for S/N 696. S/N 696 was returned by the lessee and, after undergoing certain maintenance and upgrade work, was re-leased to a regional carrier in the United Kingdom for a term expiring in April 2003. S/N 3656 was subject to a three-year lease, expiring in May 2003 with a regional carrier in Ireland. In February 2001, S/N 3656 sustained significant damage while landing. During June 2001, the Company received a settlement of $545,000 from the insurer and sold one of the aircraft's engines. The remaining components of the aircraft were sold during July 2001. The Company also retained $184,340 of maintenance reserves. The Company recorded a total gain of $382,960, as a result of the insurance settlement, the various sales proceeds, including those received during July, and the reserves retained, of which $147,750 was recognized during the third quarter of 2001. At the time of purchase, S/N 3676 (owned 50% by the Company) was subject to a 48-month lease, expiring in July 2001, with a British regional airline. The original lease, entered into in 1997, did not require that the lessee pay maintenance reserves based on usage because, at the time, the lessee was considered creditworthy. Subsequent to the Company's purchase of the aircraft, the airline's management pursued a policy of rapid expansion, which led to a financial crisis and, on February 24, 2000, the lessee filed for reorganization. The lessee continued to operate, and, under the reorganization plan, the lessee paid rentals on a month to month basis at the same rent as under the original lease on S/N 3676. Under the plan, the lessee also began paying monthly maintenance reserves based on the hours flown. Under British law, the owners were precluded from repossessing the aircraft so long as the lessee was operating it and paying rent and maintenance reserves under its reorganization plan. The lessee notified the owners that the aircraft would be returned to them during late 2000. The owners agreed that they would realize a greater benefit if they sold the aircraft "as is" rather than fund the maintenance work necessary to return the aircraft to a condition which would allow it to possibly be re-leased to a new lessee. Therefore, the Company reduced the carrying value of the aircraft to $170,000 and recognized a provision for impairment of $245,350 during 2000. The aircraft was returned to the Company and, in January 2001, it was sold. At that time, the Company received net JETFLEET III Notes to Financial Statements 2. Aircraft and Aircraft Engines Under Operating Leases (continued) proceeds of $167,450 and recognized a gain of $34,470. During the second quarter of 2001, the lessee paid all amounts owed to the Company and, since the aircraft had been sold, the Company recognized an additional gain of $77,020, representing maintenance reserves retained. S/N 24 is subject to a lease, expiring in October 2002, with a regional carrier in North America. As a result of the sale of aircraft during the fourth quarter of 2000 and 2001 and the excess cash flow generated by the Company's income producing assets, at September 30, 2001, the Company has approximately $4,000,000 to invest in additional assets. As discussed in Note 6, during October 2001, the Company signed a purchase agreement for a deHavilland DHC-8 aircraft. The Company has deposited the purchase price of the aircraft in an escrow account and expects to complete the purchase of the aircraft no later than November 30, 2001. The Company and a regional carrier in the Caribbean are currently negotiating lease terms for the aircraft. If the Company and the lessee are unable to reach an agreement regarding the lease terms, however, the Company has the right to cancel its purchase of the aircraft and retain the proceeds deposited in the escrow account. As of September 30, 2001, minimum future lease rent payments receivable under noncancelable leases were as follows: Year Amount 2001 $ 284,500 2002 656,250 2003 75,000 ------------- $ 1,015,750 ============= 3. Medium-Term Secured Bonds The Company raised $13,031,000 through the Offering from November 1995 to June 1997. Each $1,000 Unit subscribed in the offering included an $850 medium-term secured bond maturing on November 1, 2003. The Bonds bore interest at an annual rate of 12.94% through October 31, 1998 and, thereafter, a variable rate, adjusted annually on November 1, equal to the one-year United States Treasury bill rate plus 2%, but not less than 8.24%. Based on the one-year Treasury Bill rate at the measurement dates, the Bonds have borne interest at the rate of 8.24% per annum for the periods November 1, 1998 through October 31, 2000. The rate will remain at 8.24% through October 31, 2002. The carrying amount of the Bonds approximates fair value. JETFLEET III Notes to Financial Statements 4. Income Taxes The items comprising income tax expense are as follows: For the Nine Months Ended September 30, 2001 2000 ---- ---- Current tax provision Federal $ - $ - State 2,040 8,820 ------------- -------------- Current provision 2,040 8,820 ------------- -------------- Deferred tax provision/(benefit) Federal 139,010 (23,270) State 8,760 (6,200) ------------- -------------- Deferred tax provision 147,770 (29,470) ------------- -------------- Total provision/(benefit) for income taxes $ 149,810 $ (20,650) ============= ============== The total provision/(benefit) for income taxes differs from the amount which would be provided by applying the statutory federal income tax rate to pretax earnings as illustrated below: For the Nine Months Ended September 30, 2001 2000 ---- ---- Income tax expense/(benefit) at statutory federal income tax rate $ 141,370 $ (18,250) State taxes net of federal benefit 5,760 (1,020) Tax rate differences 2,680 (1,380) ------------- -------------- Total provision/(benefit) for income taxes $ 149,810 $ (20,650) ============= ============== Temporary differences and carryforwards which gave rise to a significant portion of deferred tax assets and liabilities as of September 30, 2001 are as follows: Deferred tax assets: Net operating loss $ 222,950 Maintenance deposits 397,190 Prepaid rent and other 13,970 ------------- Subtotal 634,110 Valuation allowance - ------------- Net deferred tax assets 646,010 Deferred tax liability - Depreciation of aircraft (498,650) ------------- $ 135,460 ============= The Company expects to generate adequate future taxable income to realize the benefits of the remaining deferred tax assets on the balance sheet. The Company's net operating losses may be carried forward for fifteen or twenty years, depending on when they were created, and begin to expire in 2012. JETFLEET III Notes to Financial Statements 5. Related Party Transactions The Company's Income Producing Asset portfolio is managed and administered under the terms of a management agreement with JMC. Under this agreement, on the last day of each calendar quarter, JMC receives a quarterly management fee equal to 0.375% of the Company's Aggregate Gross Proceeds received through the last day of such quarter. In the first nine months of 2001 and 2000, the Company accrued a total of $146,600 and $146,600, respectively, in management fees. JMC may receive an acquisition fee for locating assets for the Company and a remarketing fee in connection with the sale of the Company's assets, provided that such fees are not more than the customary and usual fees that would be paid to an unaffiliated party for such a transaction. The total of the Aggregate Purchase Price plus the acquisition fee cannot exceed the fair market value of the asset based on appraisal. JMC may also receive reimbursement of Chargeable Acquisition Expenses incurred in connection with a transaction which are payable to third parties. Because the Company did not purchase aircraft during the first nine months of 2001 or 2000, it did not pay any acquisition fees or Chargeable Acquisitions Expenses to JMC. During the first nine months of 2001, remarketing fees of $16,580 were accrued to JMC in connection with the sale of aircraft. No remarketing fees were accrued during the first nine months of 2000. As discussed in Note 1, the Company reimbursed JHC for certain costs incurred in connection with the organization of the Company and the Offering. The Company made no such payments during 2001 or 2000. 6. Subsequent Events During October 2001, the Company re-leased S/N 751 for a three-year term to a regional airline in the Maldives. During October 2001, the Company signed a purchase agreement for a deHavilland DHC-8 aircraft. The Company has deposited the purchase price of the aircraft in an escrow account and expects to complete the purchase of the aircraft no later than November 30, 2001. The Company and a regional carrier in the Caribbean are currently negotiating lease terms for the aircraft. If the Company and the lessee are unable to reach an agreement regarding the lease terms, however, the Company has the right to cancel its purchase of the aircraft and retain the proceeds deposited in the escrow account. Item 2. Management's Discussion and Analysis or Plan of Operation. Forward-Looking Statements Certain statements contained in this report and, in particular, the discussion regarding the Company's beliefs, plans, objectives, expectations and intentions regarding: the re-lease or remarketing of S/N 13 and S/N 674267, the purchase of a DHC-8 aircraft by November 30, 2001, the generation of future taxable income to realize the benefit of the remaining deferred tax asset, use of excess cash flow and sales proceeds to purchase assets in the third quarter of 2001, the Company's lack of significant operating expenses in connection with assets that remain on lease, the adequacy of the Company's reserves to meet its immediate cash requirements, the effect of interest rate changes on the Company's lease revenue, possible attempts by the Company's lessees to revise payment terms, the effect of rental reductions, rental collections and aircraft valuation changes on future results, the impact of the September 11, 2001 attacks on the Company's results; are forward looking statements. While the Company believes that such statements are accurate, actual results may differ due to further defaults or terminations by lessees, general economic conditions, particularly those that affect the demand for turboprop aircraft and engines, including competition for turboprop and other aircraft, air travel industry health, and future trends and results that cannot be predicted with certainty. The Company's actual results could differ materially from those discussed in such forward looking statements. Factors that could cause or contribute to such differences include those discussed below in the section entitled "Factors that May Affect Future Results." The cautionary statements made in this Report should be read as being applicable to all related forward-looking statements wherever they appear in this Report. Results of Operations The Company recorded net income of $265,990 and a net loss of ($33,020) or $0.33 and ($0.04) per share for the nine months ended September 30, 2001 and 2000, respectively. The Company recorded net income of $91,810 and a net loss of ($131,280) or $0.11 and ($0.16) per share for the three months ended September 30, 2001 and 2000, respectively. Rent income was approximately $214,000 and $115,000 lower in the nine months and three months, respectively, ended September 30, 2001 than 2000, due to the sale of aircraft during the fourth quarter of 2000 and January 2001 and the disposition of S/N 3656 during the second quarter of 2001. Gain on sale of aircraft was approximately $494,000 and $148,000 higher in the same periods of 2001 versus 2000 due to the dispositions of S/N 3676 and S/N 3656. Interest income was higher in the nine month and three month periods of 2001 by approximately $60,000 and $11,000 respectively, due to higher cash balances as a result of asset sales and excess cash flow from leases. Depreciation decreased approximately $77,000 and $45,000 during the nine month and three month periods, respectively, of 2001 due to the asset dispositions noted above. Maintenance expense was approximately $148,000 higher in the nine month period of 2001 than in 2000, primarily because of the purchase of a replacement engine for S/N 3656 in January 2001. The replacement was necessary because of hours flown by the previous lessee, which filed for reorganization and returned the aircraft during late 2000. Rather than overhaul the original engine, the Company determined that it was more cost-effective to purchase a replacement, which purchase was partially funded by maintenance reserves collected from the new lessee. Maintenance expense was approximately $68,000 lower in the three month period of 2001 because of work performed on S/N 3656 during 2000 in order to prepare it for re-lease and because of the accrual of estimated maintenance to be performed on a second aircraft which was sold later in 2000. During 2000, the Company recorded a provision for impairment in value for an aircraft sold during the fourth quarter of 2000. No such provisions have been recorded during 2001. Capital Resources and Liquidity Since Inception, the Company's funds have come primarily in the form of an initial contribution from JHC, proceeds from the Offering and rental revenue from the Income Producing Assets purchased using those proceeds. The Company's liquidity varies, increasing to the extent cash flows from operations exceed expenses, and decreasing as interest payments are made to the Unitholders and to the extent expenses exceed cash flows from leases. The Company's primary use of its operating cash flow is interest payments to its Unitholders. Excess cash flow, after payment of interest and operating expenses has been held for investment in additional Income Producing Assets. Since the Company has acquired Income Producing Assets which are subject to triple net leases (the lessee pays operating and maintenance expenses, insurance and taxes), the Company has not incurred and does not anticipate that it will incur significant operating expenses in connection with ownership of its Income Producing Assets while they remain on lease. The Company currently has available adequate reserves to meet its immediate cash requirements. The leases for the Company's aircraft expire at varying times between November 2001 and April 2003. During January 2001, the Company sold its 50% interest in S/N 3676 and received net proceeds of $204,490, including maintenance reserves retained. During June 2001, the Company received an insurance settlement of $545,000 from the insurer of S/N 3656 and sold one of the aircraft's engines. The remaining components of the aircraft were sold during July 2001. The Company received net proceeds of $1,182,340, including maintenance reserves retained. The net proceeds from sales of aircraft during the fourth quarter of 2000 and during 2001 will be used, along with excess cash flow, to purchase an additional income-producing asset for approximately $3,600,000. During October 2001, the Company signed a purchase agreement for a deHavilland DHC-8 aircraft. The Company has deposited the purchase price of the aircraft in an escrow account and expects to complete the purchase of the aircraft no later than November 30, 2001. The Company and a regional carrier in the Caribbean are currently negotiating lease terms for the aircraft. If the Company and the lessee are unable to reach an agreement regarding the lease terms, however, the Company has the right to cancel its purchase of the aircraft and retain the proceeds deposited in the escrow account. As discussed in Item 1, on February 13, 2001, the majority of the creditors of one of the Company's lessees approved a reorganization plan, which provided that unsecured creditors, like the Company, would not receive any recovery of pre-reorganization claims. In projecting its cash reserves, the Company has always anticipated that these claims would not be collected. As discussed in Item 1, the interest rate on the Bonds was 12.94% through October 31, 1998 and is a variable rate thereafter, calculated annually on November 1. The variable rate is equal to the higher of (i) 2% plus the annual yield rate on one-year U.S. Treasury Bills on the last business day of October of that year or (ii) 8.24%. Based on the one-year Treasury Bill rate at the measurement dates, the Bonds have borne interest at the rate of 8.24% per annum for the periods November 1, 1998 through October 31, 2001. The rate will remain at 8.24% through October 31, 2002. The Company's decrease in cash flow from operations was due primarily to lower net income, excluding the gain on sale of aircraft, during 2001 versus 2000 and by the effect of the change in rent receivable, accounts payable, payable to affiliates, prepaid rent, security deposits and maintenance deposits from year to year. The effect of these changes was partially offset by the effect of the change in deposits, accounts receivable and deferred taxes. The increase in cash flow provided by investing activities from year to year was due to the Company's disposition of two aircraft during 2001. There were no cash flows from financing activities during 2001 or 2000 because the Offering terminated during June 1997. Outlook As discussed in "Results of Operations", four of the Company's aircraft were sold or disposed of during the fourth quarter of 2000 and the first half of 2001. The proceeds of these sales were combined with existing excess cash flow available for reinvestment to purchase an additional asset, for which the Company signed a purchase agreement during October 2001. The Company has deposited the purchase price of the aircraft in an escrow account and expects to complete the purchase of the aircraft no later than November 30, 2001. The Company and a regional carrier in the Caribbean are currently negotiating lease terms for the aircraft. If the Company and the lessee are unable to reach an agreement regarding the lease terms, however, the Company has the right to cancel its purchase of the aircraft and retain the proceeds deposited in the escrow account. In accordance with the Trust Indenture, from November 1, 2001 through the maturity date of the Bonds on November 1, 2003, the Company will place all excess cash flow in a sinking fund account to be used solely to repay the Bonds at maturity. Because aircraft owners seeking financing generally can obtain financing through either leasing transactions or traditional secured debt financings, prevailing interest rates are a significant factor in determining market lease rates, and market lease rates generally move up or down with prevailing interest rates, assuming supply and demand of the desired equipment remains constant. However, because lease rates for the Company's assets typically are fixed under existing leases, the Company typically does not experience any positive or negative impact in revenue from changes in market lease rates due to interest rate changes until such leases have terminated. Although the lease rates the Company receives on its assets continue to exceed the interest rate paid on the Bonds, the Company is currently paying interest at a rate greater than market interest rates. In addition, while the Company leases primarily to regional airlines that operate outside the U.S., management recognizes that some customers may be adversely impacted by the September 11, 2001 terrorist attacks in the U.S. It is possible that some of the Company's lessees may approach the Company to discuss revised payment terms in light of these events. The Company is reviewing its asset valuations in light of the worldwide economic downturn. Future results could be negatively affected by rental reduction concessions, rent collections and possible reductions in aircraft values. However, management believes it is too soon to assess accurately the significance of any impact on the Company. Factors that May Affect Future Results General Economic Conditions; Recent Events. The Company's business is dependent upon general economic conditions and the strength of the travel and transportation industry. The industry appeared to be experiencing the beginnings of cyclical downturn earlier in the third quarter, and this downturn was exacerbated greatly by the terrorist attacks of September 11, 2001 and their aftermath. As a result, there has been a severe reduction in air travel, and less revenue and less demand for aircraft capacity by the major air carriers, particularly those that serve U.S. markets. The Company's lessees and targeted potential lessees have been primarily outside the U.S. It is not clear whether and to what extent the current downturn will have on the non-U.S. regional carriers that are the Company's primary lessees, and the consequent overall impact on the Company's results. It is possible that in certain instances, current economic circumstances may favor the Company, in that planned aircraft replacements for the Company's leased aircraft by its lessees may be cancelled or postponed, resulting in greater likelihood of renewals by existing lessees. Further, demand for more economically operated turboprop aircraft (which make up most of the Company's portfolio), relative to the more expensive new regional jets, may increase (see "Leasing Risks", below). At this time, it appears that large, international carriers have been most affected by these adverse events. To the extent that the Company's regional lessees depend on passenger traffic from the international carriers, they may also be adversely affected. Those regional carriers that are less dependent on the major carriers, however, may be less affected. Nevertheless, since regional carriers are not as well-capitalized as major air carriers, the downturn may result in the increased possibility of an economic failure of one or more of the Company's lessees (see "Risks Related to Regional Air Carriers", below). The combined effect of all or any of decreased air travel, an increase in the price of jet fuel due to fears of hostilities in the Middle East and increased costs and reduced operations by air carriers due to new security directives, depending on their scope and duration, could have a material adverse impact on the Company's lessees and thus the Company's results. Further, if there is substantial excess capacity for regional air carriers, the supply of regional aircraft may become out of balance with demand. If this were to occur, the Company's off-lease periods for its aircraft may significantly increase, and the value of its portfolio of aircraft could be adversely impacted. Leasing Risks. The Company's successful negotiation of lease extensions, re-leases and sales may be critical to its ability to achieve its financial objectives, and will involve a number of risks. Demand for lease or purchase of the assets depends on the economic condition of the airline industry which is in turn sensitive to general economic conditions. Ability to remarket equipment at acceptable rates may depend on the demand and market values at the time of remarketing. The market for used aircraft is cyclical, and generally, but not always, reflects economic conditions and the strength of the travel and transportation industry. The demand for and value of many types of older aircraft in the recent past has been depressed by such factors as airline financial difficulties, increased fuel costs, the number of new aircraft on order and the number of older aircraft coming off lease. The Company's concentration in a limited number of airframe and aircraft engine types (generally, turboprop equipment) subjects the Company to economic risks if those airframe or engine types should decline in value. The recent introduction of "regional jets" to serve on short routes previously thought to be economical only for turboprop aircraft operation could decrease the demand for turboprop aircraft, while at the same time increasing the supply of used turboprop aircraft. This could result in lower lease rates and values for the Company's turboprop aircraft. Ownership Risks. All of the Company's portfolio is leased under operating leases, where the terms of the leases do not take up the entire useful life of an asset. The Company's ability to recover its purchase investment in an asset subject to an operating lease is dependent upon the Company's ability to profitably re-lease or sell the asset after the expiration of the initial lease term. Some of the factors that have an impact on the Company's ability to re-lease or sell include worldwide economic conditions, general aircraft market conditions, regulatory changes that may make an asset's use more expensive or preclude use unless the asset is modified, changes in the supply or cost of aircraft equipment and technological developments which cause the asset to become obsolete. In addition, a successful investment in an asset subject to an operating lease depends in part upon having the asset returned by the lessee in serviceable condition as required under the lease. If the Company is unable to remarket its aircraft equipment on favorable terms when the operating lease for such equipment expires, the Company's business, financial condition, cash flow, ability to service debt and results of operation could be adversely affected. Ability to Repay Bonds. Beginning November 1, 2001, all excess cash flow of the Company will be placed in a sinking fund, where the funds will accumulate until maturity of the Bonds on November 30, 2003. The Company's ability to repay the Bonds will therefore depend upon continued receipt of revenues from its assets either from lease rentals or sales proceeds in an amount, when combined with the sale of the remaining assets at maturity, sufficient to repay the Bond principal. To the extent that the Company realizes less than anticipated lease rentals due to lessee rental defaults, early termination of leases, or lower than expected remarketing proceeds during the term of the Bonds or realizes significant unexpected expenses due to lessee defaults in rent or other obligations, this may result in lower than expected excess cash flow into the sinking fund. As a result, the Company's ability to repay the Bonds in full at maturity may be negatively affected by such events even if the Company is able to meet its scheduled interest payments. During the sinking fund period, all sales proceeds are required to be put in the sinking fund account, which will be invested at money market rates. The yield on funds invested in the account is significantly lower than would generally be available if the funds were reinvested in a leased asset. Thus, the ability of the Company to repay the Bond obligations will likely be strengthened if the Company can maintain its assets on lease. If an asset is unexpectedly returned to the Company during the sinking fund period, the Company may determine that it cannot re-lease the asset and/or that proceeds would be maximized by sale of the asset rather than re-lease of the asset. However, this will likely lead to less than anticipated funds available at maturity to repay the debt, due to the difference between expected lease rental revenues on the asset and money market yields on the sales proceeds. The Company's ability to repay the Bonds at their maturity date is dependent in part upon its ability to refinance the Bonds or sell its aircraft portfolio at a price sufficient to retire the outstanding Bond principal. If, due to the risks described below under "Ownership Risks" and "Leasing Risks", the values of the Company's aircraft portfolio are in a depressed state at the maturity date of the Bonds, the Company may be unable to repay the entire Bond indebtedness on the maturity date. Risks Related to Regional Air Carriers. Because the Company's leases are all with regional air carriers, it will be subject to certain risks. First, lessees in the regional air carrier market include a number of companies that are start-up, low capital, low margin operations. Often, the success of such carriers is dependent upon arrangements with major trunk carriers, which may be subject to termination or cancellation by such major carrier. This market segment is also characterized by low entry costs, and thus, there is strong competition in this industry segment from start-ups as well as major airlines. Thus, leasing transactions with these types of lessees results in a generally higher lease rate on aircraft, but may entail higher risk of default or lessee bankruptcy. Reliance on JMC. All management of the Company is performed by JMC pursuant to a management agreement between JMC and the Company. The Board of Directors does, however, have ultimate control and supervisory responsibility over all aspects of the Company and does owe fiduciary duties to the Company and its stockholders. In addition, while JMC may not owe any fiduciary duties to the Company by virtue of the management agreement, the officers of the Company are also officers or employees of JMC, and in that capacity owe fiduciary duties to the Company and the stockholders by virtue of holding such offices. Although the Company has taken steps to prevent such conflicts, such conflicts of interest arising from such dual roles may still occur. Lessee Credit Risk. If a lessee defaults upon its obligations under a lease, the Company may be limited in its ability to enforce remedies. Most of the Company's lessees are small domestic and foreign regional passenger airlines, which may be even more sensitive to airline industry market conditions than the major airlines. As a result, the Company's inability to collect rent under a significant lease or to repossess equipment in the event of a default by a lessee could have a material adverse effect on the Company's revenue. If a lessee that is a certified U.S. airline is in default under the lease and seeks protection under Chapter 11 of the United States Bankruptcy Code, under Section 1110 of the Bankruptcy Code, the Company would be automatically prevented from exercising any remedies for a period of 60 days. By the end of the 60 day period, the lessee must agree to perform the obligations and cure any defaults, or the Company would have the right to repossess the equipment. This procedure under the Bankruptcy Code has been subject to significant recent litigation, however, and it is possible that the Company's enforcement rights may still be further adversely affected by a declaration of bankruptcy by a defaulting lessee. Even if an aircraft can be repossessed, the Company may be unable to recover damages from the lessee if the condition of the aircraft when repossessed was worse than that required by the lease. International Risks. The Company's portfolio includes leases with foreign air carriers. Leases with foreign lessees may present somewhat different credit risks than those with domestic lessees. Foreign laws, regulations and judicial procedures may be more or less protective of lessor rights as those which apply in the United States. The Company could experience collection problems related to the enforcement of its lease agreements under foreign local laws and the remedies in foreign jurisdictions. The protections potentially offered by Section 1110 of the Bankruptcy Code would not apply to non-U.S. carriers, and applicable local law may not offer similar protections. Certain countries do not have a central registration or recording system with which to locally establish the Company's interest in equipment and related leases. This could add difficulty in recovering an aircraft in the event that a foreign lessee defaults. Leases with foreign lessees are subject to risks related to the economy of the country or region in which such lessee is located even if the U.S. economy remains strong. On the other hand, a foreign economy may remain strong even though the domestic U.S. economy does not. A foreign economic downturn may occur and impact a foreign lessee's ability to make lease payments, even though the U.S. and other economies remain stable. Furthermore, foreign lessees are subject to risks related to currency conversion fluctuations. Although the Company's current leases are all payable in U.S. dollars, in the future, the Company may agree to leases that permit payment in foreign currency, which would subject such lease revenue to monetary risk due to currency fluctuations. Even with dollar-denominated lease payment provisions, the Company could still be affected by a devaluation of the lessee's local currency which would make it more difficult for a lessee to meet its dollar-denominated lease payments, increasing the risk of default of that lessee, particularly if that carrier's revenue is primarily derived in the local currency. Competition. The Company has many competitors in the aircraft leasing industry, including leasing companies, banks and other financial institutions and aircraft leasing partnerships. The market is highly competitive. Most of the Company's competitors have substantially greater financial and other resources than the Company. Casualties, Insurance Coverage. The Company, as owner of transportation equipment, could be held liable for injuries or damage to property caused by its assets. Though some protection may be provided by the United States Aviation Act with respect to its aircraft assets, it is not clear to what extent such statutory protection would be available to the Company and such act may not apply to aircraft operated in foreign countries. Though the Company may carry insurance or require a lessee to insure against a risk, some risks of loss may not be insurable. An uninsured loss with respect to the Equipment or an insured loss for which insurance proceeds are inadequate, would result in a possible loss of invested capital in and any profits anticipated from such equipment. As a result of the terrorist attacks of September 11, 2001, certain insurance carriers have instituted a new $50 million limitation on war risk liability coverage. To the extent that the $50 million coverage is not sufficient to comply with lease obligations, the Company will require that its lessees acquire additional insurance, to bring coverage up to the required limits. To date, the Company believes that all of its lessees who have received notices of the new limitation have either obtained the additional coverage required or will do so before the limitation takes effect. If the additional insurance or government indemnity is not acquired in time, then the Company may ground any aircraft until it is adequately insured. SIGNATURES In accordance with the requirements of the Exchange Act, the Registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. JETFLEET III (Registrant) Date: November 14, 2001 By: /s/ Neal D. Crispin ------------------------------- Neal D. Crispin Title: President